The Russian-Ukrainian gas compromise

The agreement which ends the several weeks-long gas dispute between Russia and Ukraine benefits both sides, but Ukraine gains more

On 4 January, Ukraine and Russia reached a compromise that ended their prolonged gas dispute. Financially, the agreement is beneficial for both sides, although Ukraine has managed to win more for itself: Gazprom will sell gas to Kiev through its daughter company RosUkrEnergo at US$95 per 1000 m3, i.e. at nearly twice last year's price, but the price is still much lower than what the Russian monopoly had tried to impose during the conflict (the price quoted by the Russians then was US$230 per 1000 m3). The information that Gazprom would sell gas to RosUkrEnergo at US$230 per 1000 m3 should be seen as a propaganda manoeuvre enabling Gazprom to end the conflict without losing face. The agreement that was reached will also generate profits for RosUkrEnergo, a company whose origins are not entirely clear, and which is probably linked to the Russian government elite and Ukrainian business circles.

The way in which the Russian-Ukrainian conflict developed clearly shows that the actual objectives pursued by the Russians went beyond their declared aim of 'gas trade liberalisation.' By using gas supplies as an instrument of pressure, Russia tried to ensure long-term economic and political domination in its relations with Ukraine. If these had indeed been Russia's objectives, the outcome of the conflict marks a failure of the Russian strategy.

The agreement was signed unexpectedly after several days of very heated clashes between the two sides. On 1 January, Gazprom made good its previous threats and limited the volume of Russian gas supplies to Ukraine. Russia declared that the gas sent via Ukrainian pipelines was meant exclusively for transit to third countries. By 2 January, individual European countries had observed a decrease in the volume of Russian gas they received in comparison to the amounts ordered; the degree of this decrease ranged from 50% in the case of Serbia, to 25-40% in the case of France, Italy, Slovakia, Hungary and Austria. In the evening of 2 January, Gazprom announced that it would increase supplies to Central and Western Europe by 95 million m3 per day, in order to meet its supply contracts. The conflict was accompanied by very harsh rhetoric on both sides. Russia accused Ukraine of stealing Russian gas, and the authorities in Kiev referred to Russia's actions as energy blackmail.

Under the agreement concluded on 4 January, as of 1 January 2006 gas will by supplied to Ukraine by RosUkrEnergo, a Gazprom daughter company. The company will purchase gas from Gazprom at US$230 per 1000 m3, mix it with the much cheaper Central Asian gas (which is also purchased by Gazprom), and then sell it to Ukraine at US$95 per 1000 m3. In 2006, Ukraine will import 16.5 billion m3 of gas from Russia, purchase 40 billion m3 from Turkmenistan under a previously signed deal with that country, and produce 20 billion m3 domestically. The parties also agreed to increase the charges for gas transit via Ukraine from US$1.09 to US$1.60 per 1000 m3 per 100 km, and emphasised that the transit rate was not related to the price of gas. In addition, they decided to introduce cash settlements for both gas supplies and transit (Russia has previously paid for transit in gas). The gas Ukraine received during the first few days of 2006 will be included in the contract. Finally, the Ukrainians announced that Naftohaz Ukrainy and RosUkrEnergo would establish a joint undertaking to provide gas services to industrial customers on the Ukrainian market, and would provide 34 billion m3 of gas to those customers in 2006.

In financial terms, the agreement is a compromise, but Ukraine has nevertheless gained much more than Russia. Under the agreement, Gazprom will in practice sell gas to Ukraine at US$95 per 1000 m3, i.e. received nearly twice last year's cost, but a rate which is still much cheaper than it had threatened to do during the conflict (Russia had demanded US$230 per 1000 m3). The Central Asian gas, which RosUkrEnergo will mix with Gazprom's gas, is also purchased by the Russian monopoly - that is to say, it also is Gazprom's property. Hence, the information that Gazprom will sell gas to RosUkrEnergo at the price of US$230 per 1000 m3 should be seen as a propaganda move made by Gazprom to end the conflict without losing face. Ukraine also obtained an increase in transit prices, as well as a guarantee of deliveries during 2006 of previously contracted cheap gas from Turkmenistan (which is delivered via Russian territory); Ukraine had not previously had any transit agreement with Russia about this matter.

The compromise will also certainly benefit RosUkrEnergo. The company will profit from direct access to Ukrainian consumers. In addition, it will strengthen its position and become a permanent element in the system of regional gas dealings. RosUkrEnergo was established in July 2004 by companies controlled by Gazprombank (50% of shares) and the Austrian Raiffeisen banking group (Raiffeisen Investment AG), and incorporated in the Swiss tax haven of Zug. However, it is not clear whom Raiffeisen Investment AG is really representing, nor who actually manages the company. There are many indications that RosUkrEnergo is another in a series of several companies doing business in the CIS energy market (as of 1 January 2005, RosUkrEnergo replaced Eural Trans Gas Kft, and in the period 1994-2001, Itera performed a similar role), which people linked to Gazprom or the Russian ruling circles use to pursue their private interests and to channel the monopoly's funds to private accounts. RosUkrEnergo probably has similar connections to the Ukrainian business elite.

According to official statements by Russia, the purpose of Gazprom's gas price increase was to stop 'sponsoring' the former Soviet countries, and to introduce market mechanisms into the gas trade in the post-Soviet area. However, the way in which the Russian-Ukrainian conflict unfolded plainly showed that the actual objectives Russia was pursuing went beyond what had been declared openly. It appears that Moscow wanted to use gas as an instrument of pressure to achieve the following objectives: 1) to compel Kiev to surrender control of the Ukrainian transit pipelines to Russia, 2) to damage the "orange" government's popularity before the March parliamentary election in Ukraine, and finally 3) to discredit Ukraine's reputation in the EU, in order to thwart any further development of political and economic co-operation between Kiev and Brussels, and also to gain another argument in favour of the trans-Baltic pipeline's bypassing Ukraine.

The following elements of Russia's policy may be cited in support of this interpretation of Russia's intentions:

1. Gazprom declared its readiness to exchange its gas debts for assets in Ukrainian enterprises that are 'important for the company', in case Ukraine is unable to pay in cash for its gas purchased at the price of US$230. 2. The gas ultimatum was part of a broader economic war waged by Russia against Ukraine in recent weeks. As of 30 December 2005, Russia introduced a ban on meat imports from Ukraine, and on 29 December anti-dumping customs duties were imposed on certain types of steel pipes imported from Ukraine for a period of five years. 3. The price increases for Ukraine were much higher than for the other post-Soviet countries to whom Russia had also declared the need to introduce market principles into their gas transactions (for example, the price offered to the Baltic States was US$125 per 1000 m3).

If Russia's objectives had indeed been those defined above, the conflict and its outcome mark the failure of Russia's strategy. Firstly, Ukraine firmly refused to give up control over its transit gas pipelines. Secondly, the gas dispute did not affect the popularity of the Ukrainian leadership adversely. Finally, Western media and politicians perceived the reduction of gas supplies to the EU for over 24 hours due to the conflict as undermining the credibility of Russia, and not that of Ukraine.

Throughout the negotiation process, Russia did not display any desire to reach an agreement, and the solutions proposed by Gazprom (i.e. their proposal of 31 December to postpone the introduction of the US$230 per 1000 m3 price until 1 April 2006) were unacceptable to Ukraine. The compromise was possible mainly because Russia finally abandoned its confrontational position. This decision was probably influenced by the fact that Russia had realised that its political objectives behind the gas war had failed. In particular, this refers to the critical reactions from Gazprom's most important customers to the reduced volume of gas supplies, which were addressed to Moscow rather than to Ukraine, as the Russians had expected. Moscow has also learnt that at present it does not have sufficient means of pressure to force Kiev to fully comply with Gazprom's conditions. The involvement of RosUkrEnergo may also have played a role in brokering the agreement. The company, which undoubtedly has links to important people on both sides, was interested in a compromise and may have lobbied for agreement. However, it is difficult to assess how much influence it really had on the negotiations.

The compromise does not put an end to Russian-Ukrainian gas problems. The agreement that was signed does not specify the terms and conditions of gas trade in 2007, when Russia is to take full control of all gas imported from Central Asia. At that point, Ukraine will not be able to conclude a separate deal with Turkmenistan, and will have to buy all of its gas imports from Russia. It is therefore highly likely that the conflict will repeat itself in a year, and at that time Ukraine will be in a much more difficult position.

The Ukrainian-Russian gas conflict should be viewed in a broader context as a further demonstration of Russia's ongoing policy towards Ukraine as well as those other post-Soviet countries that aim towards integration with the West. This policy is based on the use of economic tools to restore Russia's political and economic dominance in relations with these countries. This policy is not only exemplified by the recent Ukrainian crisis, but also among other things by the measures taken in relation to Moldova. That country was also offered very steep increases in gas price rates, from US$70 to US$160 per 1000 m3, and since no agreement was reached, supplies have been suspended as of January 2006. Moreover, as of 18 April 2005, Russia imposed a ban on meat imports from Moldova, and as of 1 May 2005, a ban on Moldovan vegetable products. On 9 November 2005, the Moldovan Thermal Power Plant in Transnistria, which is wholly owned by Russia's RAO EES, stopped energy supplies to Moldova.

In order to maintain its dominant position in the region, Russia is even prepared to take actions that may destroy the stability of the countries concerned. It also employs very radical methods that include inducing serious crises, aggressive propaganda campaigns based on disinformation, or even cuts in energy resource supplies, as in the case of the Ukrainian crisis.

The gas conflict has once again demonstrated the Russian government's inability to adequately assess the situation (i.e. their own capabilities and the possible reactions in the wider world). This affects the efficacy of the measures that the Kremlin takes on the international stage.

I imagine that Russia's biggest customers, that would be Germany perhaps, did have something to add to the mix when it came to compromise.
Just a guess.
Nothing quite so complex in the world like gas and oil pipe line through other countries to complicate prices.
It's also my guess that even the media < sarcasm > won't ever find out what the real compromises were to this deal. The real brokers of the deal are powerful enough to elude even the media < even more sarcasm >.

I read the article and it is WRONG! I am an investor in gas and I can tell you for a fact this article has many inaccuracies. I only have a little time, but will point out a couple.

Firstly, there is a world shortage of gas. My own gas bill in America almost doubled this month over last year. We currently are paying over $450 per cu meter here. The ostensible reason was that Ukraine refused to pay a 450% price increase for Russian gas demanded by Gazprom for its delivered gas.

That is very inaccurate. The Ukraine was offered gas at $160, but Gazprom also offered to up the transit fees from $1.09 to $1.60 to offset the increase. The Ukraine refused, because it stopped them from siphoning off gas by making them responsible for the shortages. The Ukraine DEMANDED $3 transit fees, which would have given all their gas for free. It was only then Russians increased the total to $230.

The Gazprom Ukraine dispute opened the Pandora’s box of confidential gas pricing to the world as Russia revealed Western customers paid some $450 tcm compared with the then $50 tcm Ukraine enjoyed.

This $450 is exactly the figure I quoted earlier. Actually I quoted $451. However, Russians pay $60 to heat their homes. Why should the Ukraine get a better price...DELIVERED? The article is also DEAD WRONG in stating their is not a world market price for the gas. There is a price, but it varies due to the delivery system and availability. The fact that there is not a huge abundance is seen by the fact Russia has had to cut Europe back 20% due to a present shortage needed for the cold wave.

The person who wrote this article doesn't have a clue regarding business and the need for infrastructure. Having reserves of gas is not the same as having the gas to sell. You have to find the gas, drill the wells, and then have the means to deliver it. That costs megabucks, and this person is trying to turn this into a geopolitical battle. He is ignorant as hell, and you can tell him I said that.

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